An ill-advised new policy for contractors gambles with American livelihood

This week, the Department of Labor’s new rule on independent contracting goes into effect. It will now be more difficult to engage in freelancing, gig work or certain types of independent work — a Biden administration labor-agenda standard that is far stricter than it was under the Trump or Obama administrations.

The rule intends to combat misclassification problems and make more independent contractors become employees with access to proper benefits and protections. But while it may diffuse pressure from activists who have taken issue with the gig economy, this is not a simple “labor wins” story.

That’s because it’s impossible for every independent work opportunity affected by this rule to turn into a traditional, full-time job. Instead, it would leave many workers with fewer job opportunities altogether.

Take, for example, an organization that works with a freelance graphic designer on a sporadic basis. If the contracting relationship is now illegal, will the organization hire this part-timer and provide full-time benefits, or simply end the relationship? It depends on whether there is enough work to justify the additional costs. To fill the gap, the organization may ask other employees to take on the graphic designing tasks or jump on the AI bandwagon and have Dall-E3 fulfill their requests.

This is not an entirely hypothetical example. It was the reality for thousands of California freelancers after the passage of their state’s AB5 — the nation’s strictest independent contracting regulation — and it may now be the reality for millions of other workers nationwide.

After AB5 went into effect, news outlets like the New York Times and the Los Angeles Times highlighted similar job losses, especially among freelance musicians, classical performers, truck drivers, translators, editors and writers. Following this backlash, California exempted these professions and many others.

But the job losses go beyond anecdotal evidence. In our recent analysis of California’s AB5, which is the first empirical investigation of the law, my co-authors and I find that it is associated with a significant decline in overall employment and self-employment for affected occupations. Self-employment fell by 10.5 percent for non-exempt occupations. Overall employment fell by 4.4 percent in the same professions.

Not only that, but AB5 didn’t appear to make up for these job losses by putting more employees on traditional payrolls with better stability, benefits or protections. Our study found no consistent evidence of more workers becoming W-2 employees.

In other words, on average, 1 in 10 affected Californians lost self-employment opportunities, and we see no reason to believe they replaced them with better jobs.

It’s worth noting that some California jobs were saved when more than 100 professions and industries were exempted from AB5. But the DOL’s rule cannot exempt any professions or industries, which means it will have far more significant and wide-reaching consequences across the U.S. economy.

Like in California, small businesses and nonprofit organizations nationwide will face harsher consequences than larger companies. That’s partly because the costs of hiring payroll employees are higher than working with a contractor, and partly because the new complexity of the rule may deter organizations that cannot afford extensive legal counsel from working with contractors altogether, even if they’re properly classified under the new rule.

Another government agency, the Small Business Administration, submitted a public comment raising concerns like these. Moreover, according to IRS tax records, the growth of independent contractors has been fastest for small and low-wage businesses (fewer than 20 employees), followed by medium firms (20-100) and lastly by large firms (more than 100). 

Far from delivering its intended gains, the Department of Labor’s new rule on independent contractors will likely harm this growing segment of the labor force without the added benefits of helping more workers become employees.

Instead of limiting work opportunities, policymakers should provide independent contractors with more desirable options through flexible benefits that allow them to maintain their nontraditional arrangements while accessing work-related benefits. Flexible and independent forms of work aren’t going anywhere, and such a system is the only sustainable solution in the long term.

Liya Palagashvili is a senior research fellow with the Mercatus Center at George Mason University and co-author of the study “Assessing the Impact of Worker Reclassification.” She analyzes labor economic policies in her Substack, Labor Market Matters.